The exemption would block input-tax credit that would have an adverse impact on businesses and may not result in any significant gain to consumers, two finance ministry officials said on Tuesday.

The government may not accept industry demands to substantially reduce the Goods and Services Tax (GST) for six months to boost demand in the aftermath of the coronavirus disease (Covid-19) pandemic. The exemption would block input-tax credit that would have an adverse impact on businesses and may not result in any significant gain to consumers, two finance ministry officials said on Tuesday.

Input tax credit reduces the tax paid on inputs from taxes to be paid on output of finished goods.The proposed GST exemption will make output tax zero, blocking the input-tax credit, which will add to the cost of the finished goods, the officials with direct knowledge of the matter said, requesting anonymity.

“This will not only be injurious to the industry but also to the consumer at large and this is certainly not going to revive demand,” one of the officials said.

GST is an integrated levy of indirect taxes and the main source of revenue for both the Centre and state governments. It makes up about one-third of total tax receipts. Over 70% of the GST revenue accrues to the states as their own share of the receipts and funds devolved on them by the Centre.

Demand generation looms as a major challenge after the Covid-19 lockdown is lifted and a substantial reduction in GST rates could stimulate demand, some industry associations have argued.

Niranjan Hiranandani, president of the Associated Chambers of Commerce and Industry of India (Assocham), has proposed a cut in GST rates on almost all products by 50% for six months to boost demand.

Responding to the finance ministry officials’ comments, Hiranandani said on Tuesday: “In theory, yes – lost input tax credit (ITC) on exemption from GST is an issue of concern...”

He added: “It has to be viewed from the perspective of incentivizing consumers by inducing them to make a purchase, leading to the consumption which is the need of an hour. The argument is that a cut in GST for a short term, say next six months, will reduce the amount paid for the good or service, so the consumer will buy more and thereby, revitalize the economy. It is a simple issue of reducing (not exempting) GST, so that consumers go ahead and buy – in the present, during the period of reduced GST rather than keep waiting for some other day to do so.”

The logic is that demand generation needs GST cuts. he said.“The aspect of ITC can be dealt with so long as the suggestion is taken in the proper perspective.”

Experts counselled the government to adopt a cautious approach. “There does not appear to be any empirical evidence that any country has exempted GST/VAT [value-added tax] across the board in order to drive up the pandemic-impacted economies. There could be specific sectors/areas where there may be a need to rationalise the GST rates for a temporary period to assist the sector. This needs be done very cautiously ensuring that revenue losses are minimised, leakages are avoided and the reductions do not lead to emergence of inverted duty structure situations,” said MS Mani, partner at Deloitte India.

Inverted duty structure is a situation in which inputs are taxed at a higher rate than finished goods.

Abhishek Jain, tax partner at consulting firm EY, said a GST exemption would entail breaking of the credit chain, higher input tax costs for businesses and complexities in compliances with credit transitions during taxable and exempt-tax periods.

“A specified percentage GST rate reduction could be explored vis-à-vis a NIL rate/exemption by the government specifically for the severely impacted sectors. In a scenario, where the said rate reduction entails accumulation of credits, the government should ensure full refund of the credits so accumulated with faster processing of such refunds,” he said.

Pratik Jain, partner and leader of the indirect tax practice at PwC India, suggested making GST concessions an exception for industries such as airlines and hospitality that have borne the brunt of the fallout of the Covid-19 crisis.

“In addition, the government should consider providing working capital cushion to industry by deferring the payment of GST collected by few months to industry at large, without payment of any interest,” Jain said.